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Legal & General (LSE: LGEN) shares’ 8.9% return is nearly two-and-a-half times the average FTSE 100 yield of 3.6%. And it is getting close to three times the FTSE 250’s 3.3% payout.
So, investors considering an £11,000 (the average UK savings) stake in the firm would make £979 in dividends in the first year. If the yield evened out at 8.9% over 10 years, these payouts would rise to £9,790, and over 30 years to £29,370.
The ‘miracle’ of dividend compounding
This income is a lot more than could be made in a regular UK savings account. But it could be even greater using the standard investment process of ‘dividend compounding’. This involves using the dividends paid by a firm to buy more of its shares.
Using this method would generate £15,699 in dividends after 10 years, not £9,790, provided the yield was 8.9%. And on the same basis, the dividend income after 30 years would be £146,282 rather than £29,370!
With the initial £11,000 added in, the total value of the Legal & General holding would be £157,282. This would pay an annual dividend income of £13,998 by then, or £1,167 every month.
Is the stock undervalued as well?
Nobody wants their dividend income gains reduced by share price losses in the event of selling the stock.
To reduce the chances of this happening, I only ever buy shares that appear undervalued to me. Conversely, of course, it also increases the potential for an additional profit to be made on a share price gain.
In Legal & General’s case, a discounted cash flow analysis using other analysts’ figures and my own shows the stock is technically 62% undervalued.
Therefore, a fair price for the shares – currently priced at £2.29 – is £6.03. This does not guarantee that they will reach that level, given the vagaries of the market. But it does strongly indicate to me that they look extremely cheap at their present price.
A risk here is any new financial crisis that could cause customers to cancel their policies. However for now, consensus analysts’ forecasts are that Legal & General’s earnings will grow by 24.14% every year to end-2026.
And it is earnings growth that powers increases in a firm’s yield and its share price over time.
Will I buy more of the shares?
I have added to my holding of Legal & General shares several times over the years based on three factors.
The first – and core reason – is its exceptional earnings growth potential. This remains intact as far as I am concerned.
The second is its extremely high yield and the prospects that this will be sustained. Again, this still holds good, in my view. Analyst estimates are that the stock’s yield will rise to 9.5% in 2025 and to 9.8% in 2026.
And the third is its undervaluation. This also looks to be in place, so all three key reasons for my buying it are still in play.
Consequently, I will be buying more Legal & General shares very soon.
